Financial accounting the impact on decision makers 9e chapter 4

Chapter 4
Income Measurement and
Accrual Accounting


Recognition and Measurement
in Financial Statements
 Recognition:

process of recording an item as an
asset, a liability, a revenue, an expense, or the
like
 Measurement: requires two choices to be made
 Choice

1: The attribute to be measured

• Historical cost
• Current value
 Choice

2: The unit of measure—yardstick

• Money
LO 1


Exhibit 4.1—Recognition and
Measurement in Financial Statements

Cash and Accrual Bases of
Accounting
 Cash

basis: revenues are recognized when cash
is received and expenses are recognized when
cash is paid
 Accrual basis: revenues are recognized when
earned and expenses are recognized when
incurred

LO 2


Example 4.1—Comparing the Cash
and Accrual Bases of Accounting


Exhibit 4.2—Comparing the Cash
and Accrual Bases of Accounting


The Revenue Recognition Principle
 Recognized

in the income statement when they
are realized, or realizable, and earned
 Revenues: Inflows of assets or settlements of
liabilities
 Delivering

or producing goods
 Rendering services
 Conducting other activities

LO 3


Expense Recognition and the
Matching Principle
 Association

of revenue of a period with all of
the costs necessary to generate that revenue
 Direct

matching: associate revenues of a period with
their costs
 Indirect matching: associate costs with a particular
period
• Example: depreciation on building
 Expenses

incurred in two different ways:

 From

the use of an asset
 From the recognition of a liability

LO 4


Example 4.3—Comparing Three Methods
for Matching Costs with Revenue


Adjusting Entries
Made at the end of an accounting period
 internal transactions and do not affect the Cash
account
 Adjustment of either an asset or a liability with a
corresponding change in revenue or expense
 Types of adjusting entries:


Deferred expense
 Deferred revenue
 Accrued liability
 Accrued asset


LO 5


Deferred Expense
 Cash

paid before expense is incurred
 Example:

 Prepaid rent
 Prepaid insurance
 Office supplies
 Property

 Unexpired
 Written

and equipment

costs are assets

off and replaced with an expense as the
costs expire


Example 4.4—Adjusting a Deferred
Expense Account


Deferred Revenue
 Cash

received before revenue is earned
 Example:
 Insurance

collected in advance
 Subscriptions collected in advance
 Gift certificates

 Initially

recorded as liabilities (unearned or
refundable receipts) and recorded as revenues
in future periods when earned


Example 4.6—Adjusting a Deferred
Revenue Account


Accrued Liability
 Cash

is paid after an expense is actually incurred
rather than before its incurrence
 Examples:
 Payroll
 Taxes
 Utilities


Example 4.8—Recording an Accrued
Liability for Wages


Accrued Asset
 Revenue

earned before the receipt of cash

 Example: Rent and interest are earned with the
passage of time and require an adjustment if
cash has not yet been received
 Whenever a company records revenue before
cash is received, receivable is increased and
revenue is also increased


Example 4.10—Recording an Accrued Asset
30 adjustment to recognize insurance
expense:


Accruals and Deferrals
30 adjustment to recognize insurance
expense:


The Accounting Cycle
Series of steps performed each period and
culminating with the preparation of a set of
financial statements

30
adjustment to recognize insurance
expense:

LO 6

Exhibit 4.5—Steps in the
Accounting Cycle


Work sheet
Device used at the end of the period to gather
the information needed to prepare financial
statements without actually recording and
posting adjusting entries

30
adjustment to recognize insurance
expense:


Closing Entries
 Made

at the end of an accounting period
 Return the balance in all nominal accounts to
zero
 Transfer the net income or net loss and the
dividends of the period to the Retained Earnings
account


Real and Nominal accounts
 Real accounts:

balance sheet accounts

 Permanent

in nature
 Not closed at the end of the period
 Nominal accounts: revenue, expense, and

dividend accounts
 Temporary

in nature
 Closed at the end of the period


Closing Process
 All

revenue accounts is credited to Income
Summary—single entry is made
 All expense accounts is credited to Income
Summary—single entry is made
 Credit balance in the Income Summary account is
transferred to Retained Earnings
 A credit is made to close the Dividends account
with an offsetting debit to Retained Earnings